By Glen Monroe, CFP®, Monroe Wealth Management. Reviewed 11/8/2026.
Federal figures are for 2026. California income tax rates are from the 2025 FTB schedules, the latest available as of October 2026.
Each type of equity compensation is taxed at a different time: RSUs when they vest, NSOs when you exercise, and ISOs and ESPP shares when you sell, although ISOs can trigger the alternative minimum tax (AMT).
Tech employees based in California, whether at a pre-IPO startup or a publicly traded company, who hold any mix of ISOs, NSOs, RSUs and ESPP shares and want to know how each is taxed.
Each type of equity is taxed at a different moment. The table shows when and the sections below explain how much.
RSUs for public companies are taxed when they vest. The amount added to your W-2 as wages is the number of shares that vest multiplied by the stock’s market price on the vest date, and both income and payroll taxes will apply. The stock price when the RSUs were granted isn’t what’s taxed.
Your employer withholds federal income tax at a flat 22% on supplemental wages up to $1 million in a year (you can opt into other withholding rates by filing a new W-4), and 37% on anything above that. To cover the withholding, many companies keep some of the shares that vest (called net-share settlement), so you receive fewer shares than vested. Others automatically sell enough of the vested shares on the vest date to cover the tax (sell-to-cover).
The 22% withholding rate is why tech employees often owe more in April than was withheld. In 2026, a single filer’s rate on taxable income reaches 32% above $201,775 and 35% above $256,225. Joint filers reach 32% at $403,550 and 35% at $512,450. Because your actual rate is higher than 22%, there is usually a gap between what your employer withholds and what you owe the IRS. Payroll taxes (Social Security and Medicare) are taken out on top of the 22% and generally aren’t part of that gap.
After vesting, your cost basis is the vest-date value. If you hold and the price rises, the gain is taxed as capital gains: short-term if you sell within a year, long-term if you hold beyond one year.
NSOs are taxed when you exercise. The spread between the market value and your strike price is taxed as ordinary income, which is withheld and taxed exactly like an RSU vest. You choose when to exercise your NSOs and what year that income falls in.
At a private company, the market value is usually the most recent 409A valuation, which is an independent appraisal of the company’s common stock that’s typically refreshed at least once a year. Because that value sets your taxable spread, exercising can create a large tax bill on shares you can’t yet sell.
If your plan allows early exercise, some employees exercise right after they’re hired when the spread is small, and file an 83(b) election within 30 days to be taxed on that spread up front. This means paying for shares up front, and if you leave before they vest, you may lose some or all of that money and the tax you paid.
Your cost basis is the market value on the exercise date, so only gains above that are taxed again when you sell, as short-term or long-term capital gains.
ISOs offer the best potential tax treatment but carry the most complexity. Two moments matter most with this type of equity: when you exercise and when you sell.
At exercise, you don't owe regular income tax, but the spread (the stock's market value on the exercise date minus your strike price) counts toward the alternative minimum tax (AMT). AMT is a parallel federal calculation that applies to a broader measure of income, including the ISO spread. Each year, you owe whichever is greater: your regular income tax or your AMT.
At sale, how long you hold the shares decides how your gain is taxed. If you hold them for more than 2 years from the grant date and more than 1 year from exercise, the sale is a qualifying disposition, and your entire gain over the strike price is taxed at long-term capital gains rates. Selling them sooner results in a disqualifying disposition: the spread at exercise is taxed as ordinary income instead.
One limit: The first $100,000 of an ISO grant by a company (calculated using grant-date value) that become exercisable in a year qualify as ISOs. The rest are treated as NSOs.
An ESPP lets you buy company stock at up to a 15% discount, often based on the lowest stock price at the start or end of the offering period. You can buy up to $25,000 of stock a year, measured at the offering-date price. Nothing is taxed when you buy.
These rules apply to qualified ESPPs, which meet the requirements of IRC § 423 and are the type most employers offer. If your plan isn't qualified, the discount is typically taxed as ordinary income when you buy, so the holding periods below don't apply.
When you sell, the amount you owe in tax depends on how long you held the shares:
Federal long-term capital gains rates in 2026 are 20% on taxable income above $545,500 (single) or $613,700 (joint). Higher earners also owe a 3.8% net investment income tax (NIIT) on investment income such as capital gains, once modified adjusted gross income exceeds $200,000 (single) or $250,000 (joint). Because wages aren’t investment income, the NIIT applies to the gain when you sell, not when RSUs vest or NSOs are exercised.
Most people hold more than one type of equity, and what you do with one can change the tax you owe on the others. Find the combination that matches your equity portfolio.
Decision: whether to sell on the vesting date or hold longer term. Selling right after they vest creates little to no extra tax, because your basis equals or is very close to the sale price. Holding long term turns the shares into a stock investment, which will carry a capital gains tax if the stock increases in value above the vesting date price. Holding gives you the upside if the stock rises, but it concentrates your wealth in the company that also pays your salary. If the company struggles, your job and the gain on your shares are both at risk.
Our Take We treat an RSU vest like a cash bonus that happens to arrive in stock. If you wouldn't take that cash and buy your employer's shares with it, holding the shares is the same decision. That's a general rule, not advice for your situation: some people have good reasons to hold, such as a planned gift of appreciated shares.
Second decision: how to cover the shortfall between the 22% your employer withholds and the tax you actually owe at your bracket, often 32% or higher. Common approaches are raising the withholding on your paycheck with a new W-4, making quarterly estimated tax payments, or setting aside part of each vest in cash for the April tax bill.
Decision: when to sell ESPP shares around your RSU vest dates. Selling ESPP shares at a loss within 30 days before or after an RSU vest can trigger the wash-sale rule. The rule delays the tax benefit of the loss because the vested RSUs count as a repurchase of the same stock. Timing ESPP sales away from vest dates avoids this pitfall.
Our Take We generally see an ESPP as a savings tool with a built-in discount, not a long-term investment. Most of its value is captured the day you buy. Holding for a qualifying disposition only lowers the tax on the discount, which may not be worth a year or more of extra concentration. Whether it's worth it depends on your plan's terms and how much of your company's stock you already own.
Decision: how many ISOs to exercise each year without triggering AMT. Your RSU income raises both your income tax and your AMT income, which changes how many ISOs you can exercise before AMT applies. Many people consider exercising up to the point where their AMT and income tax obligations are equal, which is called the AMT crossover point.
The trade-off is timing. Exercising early in the year starts the one-year holding period sooner, but you commit before you know what that year’s full income looks like. Exercising in December lets you estimate AMT more accurately because you know what your income for the year will be, but it leaves less time before year-end to sell if the stock drops in value.
Our Take If the stock drops well below your exercise price before year-end, a sale in the same year (a disqualifying disposition) is often the better path. It turns the AMT bill on value you no longer have into ordinary income on the smaller amount you actually received. Whether that comes out ahead depends on your numbers, so it's worth running both before December 31.
Decision: which year to realize the NSO income. Both are taxed as ordinary income and are subject to payroll taxes. RSU vests arrive on a schedule you can’t change, but you choose when to exercise your NSOs, within your plan’s rules. Moving an exercise into a lower-income year, such as a year with fewer vests or a sabbatical, can keep more of that income out of the higher tax brackets.
Exercise timing also affects withholding. If your supplemental wages, such as RSU, NSO and bonus income, are greater than $1 million in a year, federal withholding on the amount above $1 million rises to 37%. Since the first $1 million is withheld at only 22%, there will be a shortfall between what your employer withholds and what you owe the IRS in April.
Decisions: whether to exercise before a liquidity event, and how much risk you want to take. Exercising early can start the holding period and lock in a lower spread. It also means paying the strike price, and possibly AMT or income tax, on shares you may not be able to sell for years. For a broader list of what to sort out before an IPO, see our Pre-IPO Checklist for Employees.
If you leave the company, most plans give you 90 days to exercise vested options. That deadline turns a planning decision into a forced one, so it pays to know what exercising would cost, including taxes, before you resign. We cover this in more detail in Managing Your Stock Options During a Career Transition.
Our Take Two general rules we use. First, if your strike price is higher than the current value of the shares (the options are "underwater"), exercising means paying more than the shares are worth, and we generally don't see a reason to do it. Second, at a private company, exercise only with money you could afford to lose entirely, because the shares may not become sellable, or may lose value before they do.
With ISOs, NSOs, RSUs and ESPP, the order of your moves matters. Here is a decision tree you can consider if you hold all of these equity types:
Our Take Let taxes break the tie, not make the decision. We often see people hold too much company stock to avoid a tax bill, then lose more to a price drop than the tax would have cost. Many planners use a guideline of keeping any single stock below 10% of net worth. The right level for you depends on your income, timeline and other assets.
In addition to market fluctuations, your company’s vesting schedule will also affect the value of the shares you receive on a given vesting date. Quarterly or annual vesting periods are the most common, where you receive the same percentage of outstanding shares each year/quarter. Some companies, Amazon in particular, use a back-loaded vesting schedule. Rather than receiving 25% of your RSU shares each year for 4 years, you receive only 5% of your Amazon RSU shares the first year, 15% the second year, and then 40% in each of the third and fourth years. If you haven’t taken the vesting schedule into consideration, you may find yourself expecting to have received more income in the first two years than you’ll actually be getting (market fluctuations notwithstanding).
While participating in your company’s RSU plan typically requires no more than signing your grant document, participating in their ESPP requires proactive enrollment during what is called an offering period. Your company may have only limited offering periods in which you can enroll in the plan; if you miss this window, you will need to wait until the next one before you can participate. While these do not necessarily line up with your company’s open-enrollment period or the beginning of the calendar, your benefits department should have this information at their fingertips if you ask for it.
In addition, an ESPP is subject to the lower of two different limits: an annual purchase limit of $25K worth of stock (valued by the fair market value of the stock on the first day of the offering period), or a company-determined percentage of salary (usually 10% or 15%). If your income is high enough, it may make sense to contribute less than the plan’s maximum percentage.
As an example, let’s assume someone with a salary of $300K works for a company whose ESPP limits contributions to 10% of one’s salary at a 15% discount relative to market price. Their offering period opens today, and their company’s stock is trading at a nice, round $100 per share.
If this person were to contribute 10% of their salary to the ESPP, they would end up contributing $30K per year and may expect to receive stock in the amount of approximately $35.3K ($30K/85%) when accounting for the 15% discount. Recall, however, that one is limited to purchasing $25K worth of stock as of its value at the start of the offering period. In this case, the actual maximum amount of stock this employee could purchase would be $21,250 ($25K * 85%)--not $30k, and not $25K either! The employee would be made whole and refunded their excess contribution of $8,750, but those are funds that could have been better allocated in the meantime.
To calculate the optimal contribution percentage for this example, let’s assume this company has one offering period and that it is at the beginning of the year. The calculation would be as follows:
Can I ask my employer to pay me in extra cash instead of in employer stock?
You can try, but that’s generally not something they do. Some companies like Netflix and Amazon have offered arrangements like this in the past, but even these arrangements are often set up so that the employee is incentivized to choose the equity option. Think “we’ll give you $x in employer stock based on today’s market price, or we’ll pay you $.75x in cash, subject to the same vesting periods”.
Are employers incentivized to offer equity compensation instead of paying additional cash?
Yes, for at least two different reasons. The first is that the company may feel like equity compensation incentivizes employees to go above and beyond; after all, you now participate directly in the success of the company overall. The second has to do with the company’s cash flow: shares on paper that may be worth something at some point in the future don’t come out of their proverbial cash register the way paying cash bonuses today does, even if the company experiences a lucrative liquidity event. For an early-stage company still working to get its feet underneath it, this can be the difference between making it to a successful exit and running out of money.
Aren’t my taxes lower if I wait to sell until I’ve held my shares for over a year?
That depends on which tax jurisdiction one is talking about. On a federal level, yes; long-term capital gains rates are lower than the short-term capital gains rates for assets held for a year or less. Over on the California state tax side, however, capital gains are taxed the same regardless of whether they are short-term or long-term. If you live in a state other than California, that state’s tax code will dictate the amount you owe in employer-stock-related taxes.
Every equity package interacts differently with your income, AMT and state taxes. If you'd like your own numbers modeled before your next vest, exercise or IPO, book a 30-minute call with us.
Coming next in The Equity Playbook
This is the first guide in The Equity Playbook, which discusses each combination of equity in depth, starting with what happens before an IPO. We will update the links here as they are published
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